<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VUL
DECEMBER 31, 1998
ANNUAL REPORT
SEPARATE ACCOUNT VUL FUNDING
EQUIBUILDER-TM- FLEXIBLE PREMIUM VARIABLE
LIFE INSURANCE POLICIES
Principal office located at:
#1 Franklin Square
Springfield, Illinois 62713
ANNUAL REPORT DATED DECEMBER 31, 1998
- -------------------------------------------------------------------------------
DECEMBER 31, 1998
ANNUAL REPORT
THE HUDSON RIVER TRUST
Principal office located at:
1755 Broadway
New York, New York 10019
ANNUAL REPORT DATED DECEMBER 31, 1998
- -------------------------------------------------------------------------------
The Annual Report of Separate Account VUL is prepared and provided by The
American Franklin Life Insurance Company. The Annual Report of The Hudson River
Trust is prepared by The Hudson River Trust.
- -------------------------------------------------------------------------------
This Annual Report is not to be construed as an offering for sale of any
American Franklin Life policy. No offering is made except in conjunction with a
prospectus which must precede or accompany this report.
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VUL
STATEMENT OF NET ASSETS
DECEMBER 31, 1998
<TABLE>
<CAPTION>
COMMON MONEY AGGRESSIVE HIGH
STOCK MARKET BALANCED STOCK YIELD GLOBAL
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Investments in The Hudson River
Trust, at fair value
(Cost: see below) $ 11,860,566 $ 681,117 $3,510,194 $3,232,398 $275,932 $ 1,433,210
Due from (to) general account 43,261 9,776 17,328 11,372 (732) 7,989
-------------------------------------------------------------------------------------------
NET ASSETS $ 11,903,827 $ 690,893 $3,527,522 $3,243,770 $275,200 $ 1,441,199
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
Unit value $ 412.53 $ 146.89 $ 244.11 $ 347.58 $ 255.21 $ 292.09
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
Units outstanding 28,856 4,704 14,451 9,332 1,078 4,934
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
Cost of investments $ 8,216,706 $ 682,270 $3,410,255 $3,772,246 $313,206 $ 1,104,805
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
2
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VUL
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
COMMON MONEY AGGRESSIVE HIGH
STOCK MARKET BALANCED STOCK YIELD GLOBAL
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET INVESTMENT INCOME
Income
Dividends $1,010,258 $ 27,132 $306,253 $ 395,581 $ 41,882 $ 124,213
Expenses
Mortality and expense risk charge 80,415 4,470 25,512 26,371 2,712 10,497
------------------------------------------------------------------------------------
Net investment income 929,843 22,662 280,741 369,210 39,170 113,716
NET REALIZED AND UNREALIZED
GAIN (LOSS) ON INVESTMENTS
Net realized gain (loss) 830,487 (8,208) 381,612 340,543 (3,090) 46,482
Net unrealized appreciation
(depreciation):
Beginning of year 2,618,219 1,361 236,783 207,027 16,033 225,378
End of year 3,643,860 (1,153) 99,939 (539,848) (37,274) 328,405
------------------------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) during the year 1,025,641 (2,514) (136,844) (746,875) (53,307) 103,027
------------------------------------------------------------------------------------
Net realized and unrealized
gain (loss) on investments 1,856,128 (10,722) 244,768 (406,332) (56,397) 149,509
------------------------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations $2,785,971 $ 11,940 $525,509 $ (37,122) $(17,227) $ 263,225
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
3
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VUL
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
COMMON MONEY AGGRESSIVE HIGH
YEAR ENDED DECEMBER 31, 1998 STOCK MARKET BALANCED STOCK YIELD GLOBAL
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CHANGE IN NET ASSETS
FROM OPERATIONS:
Net investment income $ 929,843 $ 22,662 $ 280,741 $ 369,210 $ 39,170 $ 113,716
Net realized gain (loss)
on investments 830,487 (8,208) 381,612 340,543 (3,090) 46,482
Net change in unrealized appreciation
(depreciation) on investments 1,025,641 (2,514) (136,844) (746,875) (53,307) 103,027
--------------------------------------------------------------------------------
Net increase (decrease) in net assets
from operations 2,785,971 11,940 525,509 (37,122) (17,227) 263,225
FROM POLICY RELATED TRANSACTIONS:
Net contract purchase payments 600,585 48,759 285,576 327,394 31,481 127,946
Withdrawals (778,678) (49,300) (371,296) (334,602) (24,258) (105,617)
Transfers between Separate
Account VUL's Divisions, net 110,608 48,095 10,572 (21,748) (1,514) (116,522)
--------------------------------------------------------------------------------
Net increase (decrease) in net assets
from policy related transactions (67,485) 47,554 (75,148) (28,956) 5,709 (94,193)
--------------------------------------------------------------------------------
Increase (decrease) in net assets 2,718,486 59,494 450,361 (66,078) (11,518) 169,032
Net assets, beginning of year 9,185,341 631,399 3,077,161 3,309,848 286,718 1,272,167
--------------------------------------------------------------------------------
Net assets, end of year $ 11,903,827 $690,893 $3,527,522 $3,243,770 $275,200 $1,441,199
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1997
CHANGE IN NET ASSETS
FROM OPERATIONS:
Net investment income $ 697,268 $ 27,579 $ 230,346 $ 269,280 $ 32,872 $ 98,272
Net realized gain (loss)
on investments 194,024 (587) 16,127 81,700 1,465 28,841
Net change in unrealized appreciation
(depreciation) on investments 994,129 5,010 111,462 (115,319) 8,418 70,860
--------------------------------------------------------------------------------
Net increase in net assets
from operations 1,885,421 32,002 357,935 235,661 42,755 197,973
FROM POLICY RELATED TRANSACTIONS:
Net contract purchase payments 663,142 82,823 369,804 385,137 27,060 126,875
Withdrawals (864,643) (69,454) (363,569) (379,212) (18,151) (224,769)
Transfers between Separate
Account VUL's Divisions, net 50,634 (75,902) (63,152) 79,780 25,832 3,884
--------------------------------------------------------------------------------
Net increase (decrease) in net assets
from policy related transactions (150,867) (62,533) (56,917) 85,705 34,741 (94,010)
--------------------------------------------------------------------------------
Increase (decrease) in net assets 1,734,554 (30,531) 301,018 321,366 77,496 103,963
Net assets, beginning of year 7,450,787 661,930 2,776,143 2,988,482 209,222 1,168,204
--------------------------------------------------------------------------------
Net assets, end of year $ 9,185,341 $631,399 $3,077,161 $3,309,848 $286,718 $1,272,167
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
4
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VUL
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. NATURE OF OPERATIONS
The American Franklin Life Insurance Company (American Franklin) is a
wholly-owned subsidiary of The Franklin Life Insurance Company. American
Franklin established Separate Account VUL (Account) as a unit investment
trust registered under the Investment Company Act of 1940. The Account,
which consists of six investment divisions, was established in July 1987 in
conformity with Illinois Insurance Law and commenced operations in January
1990. The assets in each division are invested in units of beneficial
interest (shares) of a designated portfolio (Portfolio) of a mutual fund,
The Hudson River Trust (Trust). The Account's financial statements should
be read in conjunction with the financial statements of the Trust.
The Account was established by American Franklin to support the operations
of American Franklin's EquiBuilder-TM- Flexible Premium Variable Life
Insurance Policies (Policies). Franklin Financial Services Corporation, a
wholly-owned subsidiary of The Franklin Life Insurance Company, acts as the
principal underwriter, as defined in the Investment Company Act of 1940, of
the Policies. The assets of the Account are the property of American
Franklin. The portion of the Account's assets applicable to the Policies is
not chargeable with liabilities arising out of any other business American
Franklin may conduct. New Policies are no longer being issued.
The net assets of the Account may not be less than the reserves applicable
to the Policies. Assets may also be set aside in American Franklin's general
account based on the amounts allocated under the Policies to American
Franklin's Guaranteed Interest Division and for policy loans. Additional
assets are set aside in American Franklin's general account to provide for
(i) the unearned portion of the monthly charges for mortality and expense
risk charges made under the Policies and (ii) other policy benefits.
2. SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies of the Account are as follows:
Investments in shares of the Trust are carried at fair value using the net
asset values of the respective Portfolios of the Trust corresponding to the
investment divisions of the Account. Investment transactions are recorded
on the trade date. Dividends are recorded as received. Realized gains and
losses on sales of the Trust shares are calculated on the specific
identification method.
The operations of the Account are included in the federal income tax
return of American Franklin. Under the provisions of the Policies,
American Franklin has the right to charge the Account for federal income
tax attributable to the Account. No charge is currently being made
against the Account for such tax since, under current tax law, American
Franklin pays no tax on investment income and capital gains reflected in
variable life insurance policy reserves. However, American Franklin retains
the right to charge for any federal income tax incurred which is
attributable to the Account if the law is changed. Charges for state and
local taxes, if any, attributable to the Account may also be made.
5
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VUL
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
3. SALES AND ADMINISTRATIVE CHARGES
Certain jurisdictions require that deductions be made from premium payments
for taxes. The amount of such deductions varies and may be up to 5% of the
premium. The balance remaining after any such deduction, the net premium, is
placed by American Franklin in a Policy Account established for each
policyowner. Each month American Franklin makes a charge against each Policy
Account for: administrative expenses (currently $6 per month plus an
additional charge of $24 per month for each of the first 12 months a policy
is in effect); and cost of insurance, which is based on the insured person's
age, sex, risk class, amount of insurance and additional benefits, if any.
In addition, American Franklin will make charges for the following: a
partial withdrawal of net cash surrender value (currently $25 or 2% of the
amount withdrawn, whichever is less); an increase in the face amount of
insurance (currently a $1.50 administrative charge for each $1,000 increase
up to a maximum charge of $300); and a transfer between investment divisions
in any policy year in which four transfers have already been made
(up to $25 for each additional transfer in a given policy year). Charges may
also be made for providing more than one illustration of policy benefits to
a given policyowner. American Franklin assumes mortality and expense risks
related to the operations of the Account and deducts a charge from the
assets of the Account at an effective annual rate of .75% of the Account's
net assets to cover these risks. The total charges paid by the Account to
American Franklin were $1,118,000 and $1,036,000 in 1998 and 1997,
respectively.
During the first ten years a Policy is in effect, a surrender charge may be
deducted from a Policy Account by American Franklin if: the Policy is
surrendered for its net cash surrender value, the face amount of the Policy
is reduced or the Policy is permitted to lapse. The maximum total surrender
charge applicable to a particular Policy is specified in the Policy and is
equal to 50% of one "target" premium, which is based on the annual premium
for a fixed whole life insurance policy on the life of the insured person.
This maximum will not vary based on the amount of premiums paid or when they
are paid. At the end of the sixth policy year and at the end of each of the
four succeeding policy years, the maximum surrender charge is reduced by an
amount equal to 20% of the initial maximum surrender charge until, after the
end of the tenth policy year, there is no surrender charge. Subject to the
maximum surrender charge, the surrender charge will equal 30% of actual
premiums paid during the first policy year up to one "target" premium, plus
9% of all other premiums actually paid during the first ten policy years.
6
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VUL
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
4. SUMMARY OF UNIT VALUES AND CHANGES IN OUTSTANDING UNITS
Unit value information and a summary of changes in outstanding units is
shown below:
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
COMMON MONEY AGGRESSIVE HIGH
STOCK MARKET BALANCED STOCK YIELD GLOBAL
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Unit value, beginning of year $ 314.47 $140.51 $ 206.71 $349.91 $269.33 $ 237.70
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
Unit value, end of year $ 412.53 $146.89 $ 244.11 $347.58 $255.21 $ 292.09
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
Number of units outstanding,
beginning of year 29,209 4,494 14,886 9,459 1,065 5,352
Net contract purchase payments 1,712 356 1,294 924 115 500
Withdrawals (2,460) (439) (1,809) (977) (90) (456)
Transfers between Separate
Account VUL's Divisions, net 395 293 80 (74) (12) (462)
------------------------------------------------------------------------------------
Number of units outstanding,
end of year 28,856 4,704 14,451 9,332 1,078 4,934
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
</TABLE>
5. REMUNERATION OF MANAGEMENT
The Account incurs no liability for remuneration to directors, members of
advisory boards, officers, or any other person who might provide a service
for the Account, except as described in Note 3.
6. YEAR 2000 (UNAUDITED)
INTERNAL SYSTEMS. American Franklin's ultimate parent, American General
Corporation (AGC), has numerous technology systems that are managed on a
decentralized basis. AGC's Year 2000 readiness efforts are therefore being
undertaken by its key business units with centralized oversight. Each
business unit, including American Franklin, has developed and is
implementing a plan to minimize the risk of a significant negative impact
on its operations.
While the specifics of the plans vary, the plans include the following
activities: (1) perform an inventory of the company's information technology
and non-information technology systems; (2)
7
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VUL
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
assess which items in the inventory may expose the company to business
interruptions due to Year 2000 issues; (3) reprogram or replace systems
that are not Year 2000 ready; (4) test systems to prove that they will
function into the next century as they do currently; and (5) return the
systems to operations. As of December 31, 1998, substantially all of
American Franklin's critical systems are Year 2000 ready and have been
returned to operations. However, activities (3) through (5) for certain
systems are ongoing, with vendor upgrades expected to be received during
the first half of 1999.
THIRD PARTY RELATIONSHIPS. American Franklin has relationships with various
third parties who must also be Year 2000 ready. These third parties provide
(or receive) resources and services to (or from) American Franklin and
include organizations with which American Franklin exchanges information.
Third parties include vendors of hardware, software, and information
services; providers of infrastructure services such as voice and data
communications and utilities for office facilities; investors; customers;
distribution channels; and joint venture partners. Third parties differ from
internal systems in that American Franklin exercises less, or no, control
over Year 2000 readiness. American Franklin has developed a plan to assess
and attempt to mitigate the risks associated with the potential failure of
third parties to achieve Year 2000 readiness. The plan includes the
following activities: (1) identify and classify third party dependencies;
(2) research, analyze, and document Year 2000 readiness for critical third
parties; and (3) test critical hardware and software products and electronic
interfaces. As of December 31, 1998, AGC has identified and assessed
approximately 700 critical third party dependencies, including those
relating to American Franklin. A more detailed evaluation will be completed
during first quarter 1999 as part of American Franklin's contingency
planning efforts. Due to the various stages of third parties' Year 2000
readiness, American Franklin's testing activities will extend through 1999.
CONTINGENCY PLANS. American Franklin has commenced contingency planning to
reduce the risk of Year 2000-related business failures. The contingency
plans, which address both internal systems and third party relationships,
include the following activities: (1) evaluate the consequences of failure
of business processes with significant exposure to Year 2000 risk; (2)
determine the probability of a Year 2000-related failure for those processes
that have a high consequence of failure; (3) develop an action plan to
complete contingency plans for those processes that rank high in consequence
and probability of failure; and (4) complete the applicable action plans.
American Franklin is currently developing contingency plans and expects to
substantially complete all contingency planning activities by
April 30, 1999.
RISKS AND UNCERTAINTIES. Based on its plans to make internal systems ready
for Year 2000, to deal with third party relationships, and to develop
contingency actions, American Franklin believes that it will experience at
most isolated and minor disruptions of business processes following the turn
of the century. Such disruptions are not expected to have a material effect
on American Franklin's future results of operations, liquidity, or financial
condition. However, due to the magnitude and complexity of this project,
risks and uncertainties exist and American Franklin is not able to predict
a most reasonably likely worst case scenario. If conversion of American
Franklin's internal systems is not completed on a timely basis (due to
non-performance by significant third party-vendors, lack of qualified
personnel to perform the Year 2000 work, or other unforeseen circumstances
in completing American Franklin's plans), or if critical third parties fail
to achieve Year 2000 readiness on a timely basis, the Year 2000 issues could
have a material adverse impact on American Franklin's operations following
the turn of the century.
8
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VUL
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
COSTS. Through December 31, 1998, American Franklin has incurred, and
anticipates that it will continue to incur, costs for internal staff, third
party vendors, and other expenses to achieve Year 2000 readiness. These costs
are not passed to the divisions of the Account. The cost of activities related
to Year 2000 readiness has not had a material adverse effect on American
Franklin's results of operations or financial condition. In addition, AGC has
elected to accelerate the planned replacement of certain systems as part of the
Year 2000 plans. Costs of the replacement systems are being capitalized and
amortized over their useful lives, in accordance with AGC's normal accounting
policies.
9
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
The American Franklin Life Insurance Company
Policyowners of Separate Account VUL
We have audited the accompanying statement of net assets of Separate Account
VUL (comprising, respectively, the Common Stock, Money Market, Balanced,
Aggressive Stock, High Yield, and Global Divisions) as of December 31, 1998, and
the related statement of operations for the year then ended, and the statement
of changes in net assets for each of the two years then ended. These financial
statements are the responsibility of Separate Account VUL management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. Our procedures included
confirmation of securities owned as of December 31, 1998 by correspondence with
the custodian. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of each of the respective
Divisions constituting Separate Account VUL at December 31, 1998, and the
results of their operations for the year then ended, and the changes in net
assets for each of the two years then ended in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
Chicago, Illinois
February 16, 1999
10
